ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – MUST A SINGLE MEMBER LLC TREAT WORKERS AS EMPLOYEES? – PART 1
By Robert S. Schriebman
This is Part 1 of a 3-Part series.
An LLC (Limited Liability Company) is treated as a corporate entity for IRS and EDD purposes. LLCs must treat common law employees as W2 wage earners with the exception of a single-member LLC. A single-member LLC files a 1040 individual tax return and is not required to pay employment and withholding taxes on its sole officer-member. It must, however, pay payroll taxes on all other employees. A multiple-member LLC must treat officer-members as W2 wage earners because corporate officers are by law statutory employees. What happens when a single-member-officer-employee disregards the law and treats all workers as independent contractors? The short answer is – big problems. The Cardiovascular Center, LLC v. Commissioner (U.S. Tax Court, TC Memo. 2023-64, May 18, 2023) case is the latest Tax Court decision clearly illustrating what not to do.
In this 3-Part series, I will look at the mistakes made by Dr. K, the sole member of his medical LLC. In this Part 1, I will set forth the operative facts and the basic elements constituting control. Control is the most important single element used by the courts to determine whether an employer-employee relationship exists as opposed to an independent contractor-service recipient arrangement. In Part 2, I will examine the new 7-part analysis used by the US Tax Court to determine worker status. In Part 3, I will discuss whether “safe harbor” rules may save an employer from having to reclassify workers and pay 6-years worth of back taxes, penalties and interest.
Cardiovascular Center, LLC Case – The Facts
If you are of my generation, you may remember the early days of television, in black and white only, and the popular detective series, Dragnet, starring Jack Webb as Sergeant Joe Friday. There would always be a scene where Sergeant Friday is questioning a witness who goes off on a tangent and the good Sergeant centers them with the famous words, “Just the facts, please.”
Does the Tax Court’s analysis only apply to service providers such as a medical doctor, lawyer, or accountant? The simple answer is no. These rules and tests are universal and can be used for any type of business venture.
Dr. K practices medicine as a single member LLC. His practice is in Arizona. Between 2010-2015 the LLC employed 5 workers all doing medical-related work. Apparently, Dr. K did not wish to get his hands dirty keeping those pesky books and records and paying employment and withholding taxes. He paid all of his workers with cashier’s checks. He took out no withholdings and he never filed a quarterly or annual payroll tax return. Each worker worked an average of 70 hours every two weeks. If they put in more time, they would be paid overtime. Each worker had to submit an “employee timesheet,” which had to be approved by the office manager who was Dr. K’s live-in partner, Ms. Smith. Dr. K did not give her a paycheck per se, but paid her personal expenses including mortgages, and interest on several real properties she owned.
Between 2010-2015, Dr. K never gave any worker either a W2 or a 1099. He treated all workers as independent contractors. All workers were subject to Dr. K’s supervision and reported to him. The workers were expected to follow office procedures that were set by Dr. K. None of the workers was able to realize a profit or loss because of their services. There were no formal employment contracts. The workers determined their own schedules where they were permitted to arrive and leave at any time. The workers were directed by Ms. Smith, the office manager, and Dr. K’s girlfriend. At her direction, the workers performed both “front office” and “back office” duties. Some of these duties were administrative and some were involved in patient care, such as scheduling appointments, checking blood pressure, pulse and weight, making entries into patient’s charts, and taking patients to patient rooms.
No quarterly 941 returns or annual FUTA 940 returns were ever filed with the IRS.
The IRS audited Dr. K and issued 6-years worth of quarterly and annual payroll tax assessments together with penalties and interest to the tune of over $325,000.
What Are the Elements of Control?
The most important factor in determining an employer-employee relationship versa independent contractor is the presence or absence of control. According to the Tax Court, control is composed of the following elements:
- The principal retains the right to direct the manner in which the work is to be done.
- The principal controls the methods to be used in doing the work.
- The principal controls the details and means by which the desired result is to be accomplished.
(Coast Masonry, Inc. v. Commissioner TC. Memo 2012-233. See also Ellison v Commissioner, 55 TC 142 (1970))
In the case of Dr. K, the Tax Court found that he had total control of his workers.
The principal’s degree of control over the worker is a crucial factor in determining whether an employment relationship exists. While control is a primary factor, it is not the sole factor that determines the working relationship. In Part 2, I will discuss the new 7-factor test used by the Tax Court to determine if Dr. K and his LLC are liable for 6-years worth of back payroll taxes together with the penalties for failure to file quarterly returns and failure to pay back taxes.
Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States. He has successfully dedicated more than 50 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments. Mr. Schriebman is in private practice. He is not affiliated in any way with the EDD, and he is not employed by the EDD or any other agency of the State of California.
Robert Schriebman has written the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
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